Chapter 7 bankruptcy, also known as “liquidation bankruptcy”, allows a debtor to erase all debt that is legally capable of discharged. However, there are certain Chapter 7 bankruptcy rules which determine who qualifies, how to file for bankruptcy and what type of debt is eligible for discharge.
There are certain income criteria which determine who may file for Chapter 7 bankruptcy. In order to qualify, a filer’s income must be equal to or fall below the median income in the filer’s state and every state has different income requirements.
If a filer’s income is above the state’s median income, then the bankruptcy court will require that the filer take a “means test” in order to establish eligibility. Under the means test, filers who have the ability to repay creditors cannot file for Chapter 7 and the means test looks at the filer’s debt and income from the preceding six months.
If a filer has a certain amount of income leftover every month after paying creditors, the filer will fail the means test and will not qualify for Chapter 7. However, someone who is not eligible for Chapter 7 can still file for Chapter 13 bankruptcy which allows debtors to repay creditors in a five-year repayment plan. A filer is also ineligible for Chapter 7 bankruptcy if:
- The filer attempted to defraud creditors or the bankruptcy court;
- The filer failed to attend credit counseling;
- The filer’s income, expenses and debt would allow for a Chapter 13 filing;
- A previous debt was discharged in the last six years under Chapter 13;
- A previous debt was discharged in the last eight years under Chapter 7.
Before filing for Chapter 7, a debtor must attend credit counseling; after completing credit counseling with an agency approved by the U.S. Trustee, the debtor can file for bankruptcy with a local bankruptcy court. There is a cost associated with filing for bankruptcy and it is important to check with the Trustee’s Office to learn the exact amount. A filer is required to provide information about:
- Creditor holdings of secured and unsecured debt;
- The sale of prior property;
- A list of exempt property (anything that a filer is allowed to keep and typically includes items such as clothing, furniture, and cars).
Once a debtor files for bankruptcy, the bankruptcy court will issue an automatic stay, also called an “Order for Relief”, which protects the debtor from any attempt on the part of a creditor to collect on a debt during the bankruptcy process. An automatic stay puts an end to all collection activities, including any pending lawsuits. An automatic stay also prevents wage garnishment, filing of liens as well as any seizure of a filer’s property such as a house, car or a bank account. However, if a bankruptcy court dismisses a case, the automatic stay also terminates and the creditor is allowed to start collection activities.
A bankruptcy court appoints a trustee for each bankruptcy case and the trustee is responsible for overseeing the case to make sure that the debtor files the necessary documents. The trustee will also determine if selling nonexempt property will produce enough income to pay off creditors. If there is no substantial compensation from the property in relation to the time and effort needed to sell the property, the trustee may likely allow the debtor to keep the nonexempt property.
The trustee will schedule a creditors meeting once a filer has completed and filed all of the necessary paperwork. If the filer fails to attend the meeting, does not provide a copy of income tax returns at least seven days before the meeting or does not file a current income tax return, the trustee may make a motion to dismiss the filer’s case. A creditors meeting is typically the only time that a filer will have to go to a courthouse.
The bankruptcy court will hold a discharge meeting a few months after the creditors meeting and a debtor’s unsecured debt, or debt that is unsecured by property, is discharged; however, secured debt, such as a car loan or a mortgage receive different treatment. At the beginning of the bankruptcy process, the debtor selects one of the following options:
- Pay the creditor for the replacement value of the property;
- Return the property to the creditor, or;
- Reaffirm or agree to new contract terms with the creditor.
The following types of debt still remain after a bankruptcy discharge:
- Child support;
- Tax debt (unless criteria to discharge federal tax debt are met);
- Debt created through fraud;
- Student loans, unless a court determines there is undue hardship.
Creditors are no longer allowed to collect or attempt to collect on discharged debt once the process of bankruptcy is complete.
In 2005, Congress overhauled bankruptcy law and those changes made it harder for some to file for Chapter 7 bankruptcy. Under the law passed in 2005, the first step in figuring out if you could file for Chapter 7 is to measure your current monthly income against the median income for a household of your size in your state. If your income is less to or equal to the median, you can file for Chapter 7. If it is more than the median, you must use a means test which figures out if you have enough disposable income to make payments under a Chapter 13 plan rather than a Chapter 7 plan.
Under the means test brought forth by the 2005 law, you subtract certain allowed expenses and debt payments from your current monthly income and if the income that is left over is below a certain amount, you are eligible for Chapter 7. The 2005 law also requires all bankruptcy filers to get credit counseling before they can file a case and they are also required to get additional counseling on budgeting and debt management before their debts can be discharged.
Given the complications of Chapter 7 bankruptcy and the range of requirements that a filer has to meet, it is important that a filer consults with an experienced bankruptcy lawyer before proceeding.